Written evidence submitted by Professor
1. This memorandum is submitted in response to
the Treasury Committee's call for evidence for its inquiry into
the future of the Private Finance Initiative (PFI). The call seeks
evidence on the following points:
are the strengths and weaknesses of different public procurement
PFI debt had been on-balance sheet rather than off-balance sheet
would PFI projects have been used as much? How should PFI deals
be accounted for?
far can risk really be transferred from the public to the private
there particular kinds of risk which are particularly appropriate
for transfer through PFI deals, or particular projects which are
suited for PFI?
state guarantees are explicit or implicit in PFI deals?
what circumstances are PFI deals suitable for delivery of services?
2. My comments refer specifically to PFI schemes
except in cases where wider forms of co-operation between the
public and private sectors are included which I will refer to
under the generic title as Public Private Partnerships (PPP).
3. The accounting treatment of PFI under UK-based
accounting rules has been inconsistent, between the public and
private sectors and within the public sector. The accounting treatment
under international accounting regulation may not prove to be
adequate in view of the limited scope of application of IFRIC12/ED43.
It may be necessary to develop UK additional guidance to support
the accounting for new forms of PPP.
4. There are always implicit state guarantees
in PFI/PPP arrangements; these typically relate to service continuity
risks which cannot be transferred from public sector responsibility.
Other forms of guarantees should be limited in the extreme. Such
guarantees should be assessed at Treasury level. The total value
of any such guarantees should be placed in the public-domain by
5. It should be recognised that PFI encourages
a "capital asset based" view of public service provision,
which may not always be appropriate; that transfer of PFI principles
to new parts of the public sector is likely to be time-consuming
and expensive; and that a real choice of funding mechanisms is
needed to ensure that PFI is not the "only game in town".
6. The accounting treatment for PFI projects
has long been a matter of debate and controversy. For example,
there is evidence that, in the early years of establishing the
PFI from 1992 to 1997 and prior to the development of formal accounting
guidance, there was little in the way of disclosure of PFI contract
arrangements and development costs in the accounts of public sector
7. The development of guidance by the Accounting
Standards Board, through its application note
(FRS5A) and the revised technical note 1 of the Treasury Taskforce
(TN1R) might have been expected to promote consistent accounting
treatment of PFI deals in the accounts of both public and private
sector entities. This does not appear to have been the outcome.
One reason was that, in the public sector, FRS5A and TNIR became
de-facto alternative accounting standards, despite the technical
note being promoted as an interpretation of the application note.
A second reason is that the public sector purchasers and private
sectors operators adopted different accounting treatments or interpreted
their own risk positions differently, leading to the PFI assets
and financial obligations of some schemes failing to be recorded
in either set of their accounts. Finally, private sector operators
moved towards treating the PFI schemes as debtors, or financial
assets, as this typically benefitted them with regards to the
profile of profit recognition and tax effects.
8. There is little doubt that one attraction
of PFI deals for public sector purchasers was its ability to provide
an "off-balance sheet" accounting approach in which
neither the PFI assets nor the related financial obligations appeared
on public sector entity balance sheets. This reduced the financial
transparency inherent in these deals. It seems that the accounting
treatment was influenced by the particular regulations surrounding
the funding mechanisms in each part of the public sector; for
example local government PFI schemes were invariably off-balance
sheet in order to benefit from PFI credit funding arrangements,
while central government PFI schemes were more likely to be on
9. In the immediate future, the accounting treatment
of PFI schemes will be based upon the guidance issued by the International
Accounting Standards Board in its interpretation statement
(IFRIC12) and influenced by the 'mirror' treatment for public
sector entities proposed by the IPSASB
(ED43). This still leaves open the opportunity for inappropriate
off-balance sheet accounting because of the limited scope of arrangements
covered by IFRIC12/ED43. In periods of austerity off-balance accounting
may be particularly attractive to governments as a means of accessing
finance without having to record the underlying obligations. The
existence of weak tests for national accounting treatment under
ESA2008, also seem likely to allow an off-balance-sheet treatment
for many Public Private Partnership arrangements.
10. I believe that the scope of current PPP accounting
proposals in IFRIC12/ED43 will not prove adequate to prevent off-balance
sheet accounting for the increasing diversity of PPP structures.
It may be necessary for further accounting guidance to be developed
in the U.K. to seek to ensure that there is appropriate accounting
for PPP/PFI schemes and for the inherent obligations arising from
those projects in which significant financial and service continuation
risks remain with the public sector.
IN PFI SCHEMES
11. It is possible and usual for many risks to
be transferred to the private sector under PFI schemes. Such transfers
are appropriate where the risks are best able to be managed by
the private sector. Such transfers may be effective where the
private sector truly takes on those risks, will suffer if those
risks materialise negatively and will benefit if such risks result
in positive outcomes.
12. It would be expected that risks relating
to the construction and maintenance of assets could be transferred
in this way. However, it is not apparent that other types of risk
have routinely and successfully been transferred from the public
sector. For example, it is doubtful in PFI deals is that the risk
of service failure can be transferred from the public sector;
the taxpayer always picks up the pieces when the private sector
cannot deliver and the service has to be maintained.
13. There are always implicit state guarantees
in PFI/PPP arrangements. These relate to business continuity as
described above; when the services must be and are maintained
irrespective of the performance of the private sector. The terms
of PFI deals should reflect this underlying reality. I consider
the use of explicit guarantees above and beyond these business
continuity risks to be inappropriate to PFI/PPP arrangements unless
the terms of such arrangements are also explicit about the financial
saving to the taxpayer as a result of such guarantees. For example,
how can the private sector be said to have taken on significant
financial risk in deals which have involved the public sector
providing guarantees for the repayment of borrowing? The early
promises that PFI deals would see significant risks taken away
from the taxpayer ring very hollow when we find that project failure
results in the taxpayer covering private sector losses such as
in the Metronet scandal.
14. The imposition of state guarantees is a particular
risk in periods of reduced public spending. The danger is that
private sector finance is used to procure public investment and
avoid the direct scoring against public expenditure, while at
the same time, building up significant obligations that may crystallise
in the future. Such 'hidden' obligations should be discouraged
in the extreme. This might be done by requiring that any such
guarantees are subjected to specific approval after a value for
money test at the Treasury level and that public domain data on
signed PPP deals provided by the Treasury should also include
the total value of guarantees given to the private sector.
PFI DEALS SUITABLE?
15. Successive governments have promoted PFI
deals as being appropriate for service delivery in almost any
part of the public sector. I am not aware of there being any robust
assessment of the application of PFI across sectors, unencumbered
by either financial or public policy interests. However a number
of generalisations can be made.
16. First, the operation of PFI appears to rest
upon the need for projects to be based upon significant capital
assets such as roads, railways, hospitals and defence systems.
It should be recognised that this pushes public policy towards
a 'capital asset' solution to a particular problem and it should
always be questioned as whether or not this is appropriate.
17. Second, previous governments have underestimated
the difficulties of transferring PFI to new sectors. There seems
to have been an assumption that PFI is always a potential, and
even a likely, solution and that its principles can easily be
transferred across sectors. The reality is often different. For
example in the social housing sector, it appears to have been
assumed that PFI was equally adaptable to renovation of existing
individual properties as it had been to large new-build schemes.
There was extensive delay is signing up the first wave of PFI
social housing schemes
and subsequent lack of evidence of value for money.
It needs to be recognised that attempts to extend PFI into new
areas will be likely to be accompanied by delay and additional
costs above and beyond its application in existing areas of expertise.
18. Third, the Treasury has consistently promoted
PFI on a value for money basis. However, it has often been reported
that managers involved in developing PFI schemes have seen it
as "the only game in town". In other words, PFI was
seen as the only likely route to obtain funding to promote service
improvement. Whether this perception was accurate or not, its
result was to promote a view that managers needed to support the
PFI route if a project was to be completed. This was certainly
the impression that I received from work in the health and housing
sectors. If PFI is to continue, it needs to be assessed against
other types of funding mechanisms on as neutral a basis as possible.
This implies that Departments must be given the flexibility to
draw on different funding mechanisms as appropriate to obtain
best value for particular projects rather than treating PFI financing
as a separate (and perhaps the only) pot of money available for
a range of projects. Such flexibility should be assured without
the need to provide state guarantees or other forms of subsidy
which has brought PFI into disrepute in the past.
58 I am Professor of Public Services Accounting at
the University of Sheffield Management School. I take sole responsibility
for the contents of this memorandum and the views expressed here
should not be attributed to any organisation with which I am or
have been connected or to any person who may have worked or co-authored
papers with me. Back
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Accounting Standards Board (1998), Amendment to FRS5 Reporting
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See for example, Financial Reporting Advisory Board (2006), "'On-On'
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for Public Private Partnerships", Financial Accountability
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See the table of signed PFI deals on the Treasury web-site, which
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International Accounting Standards Board (2006), IFRIC12 Service
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